75bps rate hike? Bond market believes it could happen

The average trading volume in the gsec market is now hovering around Rs 25,000 crore, compared with the usual Rs 40,000 crore.

Mumbai: India’s bond market is pricing in a rise of about 75 basis points in the headline rates, pointing to reduced investor appetite for sovereign debt amid concerns over fiscal discipline and an across-the-board global increase in the cost of funds.

The expectations run slightly contrary to the central bank’s ‘neutral’ policy rate stance as the gap between current yields and the policy rate has reached its widest since the 2013 macro crisis.

“Most of the recent surge in yields has happened on the back of very low volumes and reflects a lack of risk appetite instead of any further deterioration in underlying macro factors,” said Suyash Choudhary, head of fixed income at IDFC Mutual Fund. “This breakdown needs to be addressed urgently… especially ahead of the new borrowing calendar.”

“The latest spread in the benchmark yield over the repo rate clearly suggests that the market is discounting a 75 bps rate hike,” he said.

The difference between the policy rate and the benchmark bond yield is now about 170-175 basis points, going by the past few trading sessions. Normally, it remains in the range of 100 basis points in a bear market, while it can contract to about 30-40 basis points in a bullish market.

Assuming a bear market for local debt investments amid a rise in US rates, the spread between the local bond yields and repo rates should settle around the long-term average of 100 basis points, market participants said. Since local bond yields will not be de-coupled from the globally rising trend in rates, the official repo should, therefore, inch up to 6.75 per cent from 6 per cent currently for the spread to return to its longterm average for a bearish market.

The average trading volume in the gsec market is now hovering around Rs 25,000 crore, compared with the usual Rs 40,000 crore. On Monday, the first trade was punched after six minutes of market opening for Rs 5 crore, dealers said.

“Nothing has changed fundamentally in the past few months, with macro factors like inflation being factored in quite a while ago,” said Ajay Manglunia, executive vicepresident at Edelweiss Financial Services. “Some regulatory comfort/intervention is required to check the free fall in bond prices. In absence of which, the consequences could be severe and investors have fear of investing.”

In the past six months, the benchmark yield has surged about 110 pulling prices down and state-owned banks are now shying away from fresh buying. Many state-owned banks are incurring mark-to-market losses. Also, the Reserve Bank of India deputy governor Viral Acharya has insisted on better risk management processes to deal with swinging bond yields.